Many businesses operate in the residential mortgage industry. Types of entities that operate in the residential mortgage industry include buyers, sellers, brokers, lenders, credit agencies, valuation and appraisal firms, title and insurance firms, financial facilitators, loan servicers, trustees and countless other intermediaries.
Mortgage origination, sales and trading are not new businesses. There are, however, many difficulties and inefficiencies in the market in its current state. Conducting due diligence on a single loan, valuing a single property, and evaluating the borrower(s) ability and willingness to reliably pay the mortgage for a property are very labor intensive, technically complex, multi-step processes. Administering a business that executes these steps thousands of times in parallel, while simultaneously monitoring and reporting progress to stakeholders and investors, requires technological and business process innovation, is a multi-dimensional challenge of time, effort, information, analysis and resources.
There are existing technologies that address scaling of specific steps and functions in the mortgage industry. There are organizations that work in some or multiple industry segments. The business processes and technologies that exist, however, are limited in several respects. Most processes and technologies lack the ability to value individual loans by specific investment exits, scale operations without sacrificing transaction speed or consistency of service, and/or track progress of each borrower and related mortgage at various stages of the overall process. Current processes and technologies are further limited in their ability to evaluate large pools of mortgages in terms of current and expected future market value. There is currently no universally accepted valuation method. Banks are understandably hesitant to make a loan secured by an asset that may deteriorate in value below acceptable standards. Investors may wait on the sideline holding cash because they are unable to determine a price that banks and mortgage owners will accept, but which also provides adequate returns to facilitate investment of financial and intellectual capital. Investors are also uncertain as to which available retail refinance and hold strategies maximize investment yields while minimizing negative effects to borrower credit or asset value deterioration. Additionally, borrowers are unsure which modification or subsidy programs will prevail in the market, and are consequently unsure whether to continue making mortgage payments or not. Industry limitations are increasing obvious when reviewing daily news reports noting how the world's leading financial firms and government agencies struggle to determine values and optimal strategies for mitigating losses and maximizing the value of large mortgage asset portfolios.
Property Valuation: For property valuations, appraisal and brokerage firms search for listing and sales price comparables. The most common forms these analyses take is that of an Automated Valuation Model (AVM), or a Broker Price Opinion (BPO). Both forms require street address level data.
The most relied upon index that tracks home price valuation trends is the Case-Shiller index, which is only valid for 40% of the United States by geographic area. It excludes new construction, only incorporates single family homes (not condos or other home types), and has several other limitations that make it impossible to rely on it exclusively as a proxy for homes price trends nationwide.
Some leading appraisal use or apply some combination of market comparables and appraiser expertise, with desktop underwriting (DU) and AVM. Many companies have some version of an AVM, but they often use data that is very broad and does not return a reliable estimate of value. Limitations of these models are similar to Case-Shiller in that they do not include enough data to produce market specific valuations. For instance, the Federal Housing Finance Agency (FHFA), formerly known as the Office of Federal Housing Enterprise Oversight (OFHEO), has a house price calculator on its website that requires only the state or MSA (Metropolitan Statistical Area), purchase calendar quarter, valuation quarter, and purchase price to return a value estimate. So, for example, data from Baltimore could influence the value of a subject home in Georgetown, a Washington, D.C. neighborhood, because the data is only MSA specific at best, which includes data from Baltimore and Georgetown, among other areas. AVMs require the analyst to select input data which introduces a high degree of variability. These valuations ostensibly take into account the property's level of finishes, amenities, location, size, age of appliances and other factors to provide some proxy of a comparable price per square foot, which can then be applied to the subject property to estimate a value range. Each lacks a realistic incorporation of market valuation trends over time, and further lack any indication as to future value based on moving averages and sales and supply/demand trends or home price indexes and futures markets which incorporate some of these influences.
BPOs require a person to travel to a property, observe and make note of appearance and property condition, occupancy, neighborhood characteristics, and other on site data as well as compare available public information about the subject property to market comparable data to estimate a value for the property. Limitations of this approach are that the evaluations are subject to human error and interpretation as well as the approach becomes unwieldy when evaluating thousands of properties in a matter of days.
Mortgage Asset Valuation: For mortgage pool valuations, the federal government, private banks and investors value mortgage pools generally use aggregate pool characteristics, taking, for example, weighted average coupon figures, general borrower credit characteristics, broadly assigning risk weightings or expected cash flow probabilities by risk level. These organizations then discount cash flows to present value using some weighted average cost of capital as the discount rate, and adjust the purchase price to back into an acceptable level of return. This approach to valuing mortgage pools is inaccurate and unreliable. Consequently, limited trading occurs because investors do not have sufficient confidence in this model. A negative feedback loop results where the markets become more illiquid, and the assets become more difficult to value for market stakeholders, which in turn makes the markets even more illiquid, etc.
Evaluating Exits: Mortgage owners and investors take a narrow approach in evaluating mortgage investment exit options. Banks at some point switched from a “lend and hold the loan on balance sheet” to a “lend, pool and securitize model”. Banks prefer the quick fees associated with mortgage origination over the lower yielding, but relatively predictable, interest income from holding the loans to maturity. Investors currently gravitate to one of three main mortgage loan strategies: 1) flip the loans to a higher bidder, 2) foreclose and sell the asset, 3) hold the loans to maturity or until the value recovers and then flip the loans.
Needs exist for improved systems and methods for asset valuation, whole loan pricing and inventory management of increasingly complex portfolios of diverse products, as well as analysis and processes to maximize value.